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Fed Hikes, BoJ Intervention, SPX Slip - All Focus on Brexit

Fed Hikes, BoJ Intervention, SPX Slip - All Focus on Brexit

Talking Points:

  • The past week showed the range of monetary policy was converging into a state of uncertainty and foreign focus
  • Thursday's Brexit vote is seen as a global event in a market that is not considered particularly durable
  • Trading should focus on reducing risk and shifting to a short-term and tactical approach

Having trouble trading in the FX markets? This may be why.

This past week made crystal clear that the world is focused on the upcoming EU Referendum vote. Besides the astronomical jump in GBP/USD implied (expected) volatility and erratic intraday swings, we have seen disconnected markets and fundamental themes pulled into the gravity of this European risk. A range of monetary policy decision - from the hawkish Fed to the extremely dovish BoJ - all turned the focus on the situation in the UK. Meanwhile, markets across asset type and region have shown a clear risk premium associated to the Brexit. Scope is clear, but will the fuse be lit?

Assessing the market's concern over the impending vote, the weight of the risk is spreading progressively further and further out. The Cable's one-week implied volatility level has soared to nearly 50. For context, that is nearly twice the peak see during the Great Financial Crisis. Further out, EUR/USD and USD/JPY have similarly experienced swells in expected volatility - the first from the existential risk posed to the Euro-area and the second reflecting the general risk implications. Short-term volatility for the entire FX market has hit a seven-and-half-year high while the tail risk in US equities (measured through the SKEW index) has risen to levels comparable to January's and August's plunge.

There is considerable event risk scheduled for the week ahead including Fed Chairwoman Janet Yellen's testimony on monetary policy before Congress. However, its influence will be defined by what happens late in the week with the Brexit vote. A hawkish tone by Janet Yellen could immediately be crushed by a vote to leave. Or, a risk move in equities and other sensitive assets to extend the multi-month, multi-year and even record highs would be turned with extreme prejudice. The fundamental evaluation for the week ahead is 'easier', but the focus breaks down technical and fundamental strategy. We consider trading conditions and risks in the week ahead in this weekend Trading Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.